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Reality Check: Changing Markets Require New Strategies

Jeff Nielson Jeff Nielson, Stockhouse
1 Comment| December 11, 2018

An era has ended. At Stockhouse, we want to make our community aware of the risks, but also cognizant of an historic opportunity. We’ll discuss the opportunity later, but first the warning.

Starting in 2009, for nearly a decade across Western markets and much of the world we have seen an unprecedented cycle in markets.

  • Unnaturally low volatility, year after year
  • Generally rising markets around the world

Bull-market runs – spread across an entire market – rarely last more than a few years. The reason is obvious: the conditions necessary to support a broad rally in markets rarely persist for more than a few years. Part of the reason for the unnatural performance of our markets for close to 10 years has been our equally unnatural economic parameters.

Click to enlarge

Specifically, reckless Western central banks crashed interest rates to zero/near-zero in 2008 and simply left interest rates at those ultra-extreme levels. This has resulted in horrendous real estate bubbles in many major urban centers, across the Western world.

It’s also resulted in some obvious stock market bubbles materializing, with the most extreme and excessive bubbles being identified with three letters: U-S-A. U.S. corporate profits went flat in 2011 and have stagnated since then. But U.S. valuations kept going straight up for nearly seven more years.

Now the U.S.’s teetering market bubbles have apparently peaked. Barring some meltdown of epic proportions, it will take at least several years for U.S. markets to retreat to a level where U.S. equities are once again rationally valued. And U.S. markets never go down alone.

For optimistic investors hoping that markets will simply shrug off recent turbulence and commence a new leg higher, there is no rational reason of any kind to expect such a development. But there is a major reason to expect current market weakness to extend into a much longer-term correction: rising interest rates.

When former Fed Chairman B.S. Bernanke led Western central banks with reckless monetary policies more extreme than anything in previous history, there was nothing subtle about his strategy. Bernanke regularly boasted about how his excessive monetary policies were juicing the performance of U.S. markets. However, unlike what Bernanke and the rest of the Central Bankers promised us back in 2008, he had no “Exit Strategy”.

It was just pump, pump, pump.

But nothing lasts forever – including the most-reckless interest rates in history. And at the abysmally slow rate at which the Federal Reserve has been normalizing interest rates, it could take another 5+ years just for U.S. interest rates to rise back to an historically normal level.

Click to enlargeThis leads to investors. Many investors have done very well for themselves over the past several years by putting their money in hot sectors and chasing momentum. Now the momentum is gone and it would be hard to identify a single sector that looks “hot”.

What’s next for the momentum-chasers?

They can exit markets and park their money on the sidelines for several years – waiting for the next opportunity to chase momentum in one-way markets. But that’s not much of an answer.

Fixed investments pay near-zero interest rates today. Moving capital from equity markets to real estate is simply suicidal at current real estate valuations. This means that few investors can afford to sit on the sidelines for several years, waiting for friendlier markets.

For some, precious metals is the answer. This is History’s #1 safe-haven investment, with both the prices of the metals and the mining companies in a long-term trough.

However, unless investors want to go all-in with gold and silver, they will need additional ideas. For many investors, this means coming up with a new investing strategy that is compatible with more difficult and volatile market conditions.

The obvious alternative to riding momentum is to invest in value. Indeed, “value investing” is investing. Buy low; sell high.

Click to enlargeIn contrast, chasing momentum is a proposition of buying high and trying to sell higher. More simply, it’s just gambling – because such bets are not based upon value but rather in simply hoping that a trend continues.

For some investors, value investing has a negative connotation, epitomized by the market metaphor “catching a falling knife”. But value investing doesn’t mean that investors need to look for companies with a stock chart that looks like a train-wreck.

In fact, one of the most tried-and-true forms of value investing is to look for companies (or sectors) that have “built a base”, or in other words, been in some form of long-term trough. The investing premise here is simple.

The longer any particular company/sector has remained in a trough, the more overdue that such a company/sector is for an extended rally. Obviously, this premise is accompanied by a basic assumption: that the economic fundamentals for the particular company or sector in question are strong and supportive.

No one would have wanted to buy stock in “Kodak” (Eastman Kodak Company) when that company went through a long-term trough as the world moved from film to digital photography. There were no fundamentals to support a rising share price.

On the other hand, silver and gold went through a long-term trough throughout the 1990’s, where prices were well below the cost of production and there were large supply deficits in both markets. The fundamentals could not have been more supportive. What followed was a 10+ year bull-market run – the longest/strongest bull market so far this century.

That’s “investing”. And many Stockhouse investors built their entire portfolios off of that one bull market.

Precious metals are once again in a long and severe trough. But so are many other resource sectors. Tech and healthcare have been trading down for extended periods. Energy stocks have been very weak. Over the past six weeks, cannabis stocks have taken a large, collective plunge.

In short, while hot sectors and strong momentum plays are now virtually non-existent, there are value opportunities to be found (especially) throughout the small-cap space. As an additional value driver, small-cap companies have been underperforming large-cap companies now for several years.

This isn’t even possible in properly functioning markets and economies. As a matter of basic arithmetic, it will always be easier for a $1 million company to become a $2 million company than for a $1 billion company to become a $2 billion company.

For value investors, this means that small-cap companies have never been more attractively valued versus large-cap companies. Never.

This is not just a value opportunity. It’s an epic value opportunity: the largest valuation disconnect in History.

How should investors take advantage of this small-cap opportunity? Carefully. As noted, we face the very realistic possibility of market headwinds for years to come. This means that investors need to be more selective in picking companies – and to be even more diligent with their due diligence.

We want to help.

That means doing more than just warning readers about the changing market conditions and alerting them to the unprecedented value opportunities with small-cap stocks. We want to help expedite your small-cap investing.

Over the next several weeks, Stockhouse will be shining a spotlight on the various sectors that make up our markets. We’ll look at current conditions in these sectors. We’ll examine what a few of the leading voices are predicting as we move into 2019. And we will even produce a few examples (in each sector) of companies that many investors may see as excellent value propositions.

Click to enlarge

Buy low; sell high. Buy and hold.

These are the basic maxims of investing. Yet in an era of runaway markets juiced by unnatural interest rates, many investors have forgotten these basic rules. Instead, egged on by market-pumping media pundits, more and more “investors” have been looking for (and expecting) instant success.

That’s not investing, it’s only gambling. And that Gambler’s Paradise is now officially history. What’s worse than being a buy-and-hold investor, waiting for (perhaps) several years for your investments to mature? Being a gambler, hoping to get rich quick, with the odds squarely stacked against you.



Thank you for the guide, Jeff. I am in the choice of several shares.
December 28, 2018

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